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Everybody's
fretting about inflation. Central bankers say there's too little, or will be
(just you wait). Lesser mortals feel there's way more than the official
numbers let on. And finance professionals think there's a lot more ahead.

"By the
time inflation becomes evident," reckons
John Paulson of the $14 billion Paulson & Co. hedge funds, "gold
will probably have moved, which implies that now is the time to build a
position."

"As
inflation picks up, the real price of gold goes up," agrees Jeremy
Grantham of the $97bn GMO in
his latest letter to clients. And the only asset class with a positive
correlation to inflation is gold, according to Credit Suisse's latest Global
Investment Returns Yearbook.

So far, so
bullish if you agree with Paulson, Grantham and pretty much everyone else
that inflation is set to start rising. Because judging by the late 20th
century - after gold
prices were cut free from their $35-per-ounce peg in 1971 - gold goes up
with inflation.

Only problem
is, gold has already moved - rising six-fold and more in nominal terms
despite the quiestest decade for official US
inflation since the 1950s.

What to make
of it? First, and to repeat yet again, gold is not
simply about inflation. It wasn't in the 1970s, nor
the 1980s, and it isn't today. Gold is about inflation and interest rates.
Because low or negative real returns on "risk free" bonds and cash
force cautious savers to turn instead to a rare, indestructible home for
their money. Which cash and bonds aren't.

Second, and
for the very same reason - that people
don't like losing value year after year - long-term bear markets in
equities are typically good for gold prices too. Because if risk capital gets
no reward, it looks elsewhere, and when risk capital keeps getting whacked,
it turns anxious and runs. Treasury bonds appeal. So does gold.

Over the last
century and more, and allowing for dividends too, the real return on US
equities has typically been negative when gold was up, and positive when gold
was down.

This patterns
held true even during the fixed-gold price era of the
Gold Standard - a period when gold's inflation-fighting power was sapped first
at $26 and then at $35 per ounce. On a five-year horizon, the real return
from stocks and gold sat on opposite sides of zero in 59% of all months since
1910. They were both up in one-third of those months. Gold and stocks lost
real value together less than 7% of the time, most of which came thanks to
world-war inflation.

Whether or
not war lies ahead again, "The 800-pound gorilla [of inflation] is not
in the room yet, but you can hear him thumping his chest up in the
hills," says Jeremy Grantham.

"He will
come eventually" - and this gorilla eats
bondholders for breakfast, of course. He gnawed on their fixed-income bones
all through the '70s, when stocks made an equally miserable investment. He'll
have a real feast destroying creditors buying bonds today at the lowest
yields in history. But where Grantham suggests buying stocks as "an
under-rated inflation hedge", the immediate costs could prove dear.

What to do?
The obvious conclusion is to buy gold
- so obvious, in fact, that there must be something wrong with it. Especially
as gold has already moved, way ahead of that inflation in consumer prices
which Grantham and the Credit Suisse report look at, as do BullionVault's charts above.

You could
argue the inflation data are wrong,
or this time is different, or that inflation simply won't show up, despite
the best efforts of central bankers worldwide to drive savers out of cash.
But what's undeniable about this bull market in gold so far is that bonds
have yet to lose their appeal, while stocks have failed to deliver positive
returns. So if or when strong inflation does show up, retained wealth will
likely find it hard to resist buying gold - no doubt alongside industrial
commodities, land and other hard assets - even after the last decade's
myth-busting performance.

Adrian Ash is head of research at BullionVault.com, the fastest growing gold bullion service online. Formerly head of editorial at Fleet Street Publications Ltd – the UK's leading publishers of investment advice for private investors – he is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.